Owners Paying More For Cash-Out Refinancing

Remember when Florida mortgage refinancing was all the rage in order to get a lower interest rate and pay less every month?

That was great. But now it’s out of date.

The craze these days, writes Kenneth Harney of the Washington Post Writers Group, is refinancing to higher home loan rates. Yes, you read that correctly.

Homeowners around the nation are doing so en masse while pulling out loads of cash. Almost 9 out of 10 homeowners who refinanced during the second quarter of this year cashed out additional money — often tens of thousands of dollars or more — according to Freddie Mac.

The 88 percent cash-out refinance rate was close to the all-time record, and the rate could surpass the record later this year.

Meanwhile, the typical refinancer hasn’t been scouring the market for Florida home loan rates lower than his or her existing mortgage.

To the contrary, Freddie Mac says, most are opting for larger replacement first mortgages with rates averaging about half a percentage point higher than on their old loan. Cash-outs may be booming, but they are not a new phenomenon. They’ve existed for years as a financial tool to extract equity tied up in real estate and to convert it to immediately spendable money.

During 2003-2004, for example, anywhere from 33-50 percent of those electing to refinance pulled out some additional cash. However, the overwhelming majority of borrowers during the go-go refinance years chose traditional rate-reduction replacement mortgages in which the new balance approximated the old balance, and monthly payment was lower than the old.

So what’s new this time?

Here in mid-2006, short-term interest rates no longer hover near 4 percent. In fact, 30-year, fixed-rate Florida home loans are no longer are in the 5s. Now the prime rate is 8.25 percent and could move higher. Standard 30-year mortgage rates are nudging percent. Even a home equity lines of credit will soon be slumping as their adjustable rates — typically set one or more points above the bank prime — start racking up bigger costs.

Now consider the near-record pace of cash-out refis:

• Say you need $40,000-100,000 for a home improvement loan, a business investment, a down payment on a vacation property or to consolidate high-cost consumer debt.
• Say you also have lots more than $100,000 sitting untouched and frozen in home equity.
• Rather than signing up for a home equity credit line tied to an unpredictable prime rate plus 1 percent, you opt for a fixed-rate cash-out refi.

In effect, you trade in your existing first mortgage — say it’s at 6.25 percent — for a replacement at 6.75 percent. Plus you pull out the money you need and add it to the principal balance of the new loan. Yes, your monthly payment will be higher than you were paying on the old loan, and yes, you’ll have transaction costs, which you might be able to roll into the new loan amount. And your total first mortgage debt may be a good bit higher than it was.

Then again, would you be happier with a $100,000 credit line with a floating rate potentially heading for double digits?

Another factor at work in the big shift to cash-out refis is the estimated $500 billion in adjustable-rate first mortgages that will experience rate resets this year, plus another $650 billion in second mortgages and equity credit lines that will adjust upward.

Many Florida mortgage loan borrowers want out of these arrangements, and fast — especially those with 40-50 percent payment increases impending upon the first reset. Refinancing into standard fixed-rate loans suddenly looks attractive. If homeowners can pull out some cash in the process, that’s just great, as real estate has likely been one of the only things making money for people in recent years.

Another key to the cash-out refi boom? A simple attitude adjustment. Many borrowers have developed new ways of thinking about their mortgages, and increasingly see them as positive resources, not just loads of debt.

So, should you consider a cash out? Not unless you have a good reason.

Certainly don’t do it without thinking it through. But, if you really need the money, you don’t want to play roulette with an adjustable-rate equity line. You want to lock in your mortgage debt at a relatively low long-term fixed rate. Check out fixed-rate second mortgages as well, as they may have lower transaction costs.